This disclosure relates to protecting a security, securities, a portfolio of securities, or a portion of a portfolio of securities and more particularly to a system and method for providing a guarantee within a deferred annuity or other form of insurance for insuring a security, securities, a portfolio of securities, or a portion of a portfolio of securities.
Investors may invest for a number of different reasons in numerous types of securities in an attempt to achieve short-term or long-term appreciation in the price or value of the security. For example, investment may be made as savings for retirement or as savings for other important financial events such as purchasing a home, purchasing an automobile, or paying for a college education. In particular, an investor among other things may invest in or obtain an interest in stocks, mutual funds, options, commodities, futures, derivatives, stock index futures, certificates of deposit, exchange traded funds, or bonds by purchasing such securities. Initially, such securities or assets have a purchase price or basis. The investor attempts to maximize the return on investment by selecting assets or securities that either increase in value or do not allow their principal to erode or decline in value. Due to the unpredictable and volatile nature of securities, investors may find it advantageous to protect the principal by preventing any loss that may occur in the purchase price or basis of the security. One way to try to protect against such an occurrence is to purchase an option contract. For example, an option contract gives an investor the right, but not the obligation, to purchase or sell a certain number of shares of stocks or other types of securities at a specific price at a specific future time. An investor pays a price for the right to purchase or sell the certain number of shares at the specific price at a future date. If the investor does not purchase or sell the stock, the investor is out the money paid to purchase the option contract. However, such option contracts are complex, difficult to understand, date limited, risky, and expensive. Further, such option contracts are only available for a limited number of stocks and cannot be purchased for other securities such as mutual funds. Accordingly and unfortunately, options contracts do not offer the protection sought or needed.
Some investors have bought government bonds or debt obligations that are backed or guaranteed by a government in an attempt to protect against a decrease in value in a security. However, such bonds pay an interest rate that is below the market interest rate making it a less attractive security. Additionally, some government-backed bonds require a large amount of money to purchase these bonds. Thus, the purchases of such bonds are only practical for large institutions, banks, or companies. Again, such bonds do not allow an individual investor the opportunity to hedge their risks.
Another known investment tool that some investors use to obtain an income stream is an annuity. An annuity is a contract between an insurance company and an individual, the insured, in which the insured pays the insurance company a premium that will later be distributed back to the insured over a period of time. An annuity contract may provide a fixed guaranteed payment over time until the death of the insured or until a final date, whichever comes first. The majority of annuity customers use annuities to accumulate funds free of income and capital gains taxes and to later take a lump-sum withdrawal without using the guaranteed payment for life feature. Annuities are available in two basic types of contracts. One is the deferred annuity and the other is the immediate or payout annuity.
Deferred annuities are essentially life insurance products through which values are accumulated, on a tax deferred basis, with the nominal purpose of applying the accumulated value on a maturity date in the future to purchase a payout annuity. The maturity date may be a planned retirement date, such as the insured reaching the age of 65. The payout annuity provides a stream of periodic payments guaranteed to be provided according to the terms selected by the insured or annuitant when the funds were applied on the maturity date. Deferred annuity products sold by life insurance companies contain investment guarantees applied to the accumulation values within the product during the deferral period. Deferred annuity products also provide interest and mortality guarantees associated with the minimum payout annuity available to the annuitant on the maturity date. However, it should be noted that deferred annuities are rarely “annuitized”. That is, rarely is the accumulated value actually applied to purchase a payout annuity. Since annuitization results in a loss of liquidity for the annuitant, well less than 5% of deferred annuities are converted to payout annuities on a maturity date.
Deferred annuity products may be further distinguished by the nature of the account value inside the product. For example, a deferred annuity may be a traditional deferred annuity, a variable deferred annuity, or an indexed deferred annuity. The account value of a Traditional or General Account deferred annuity is invested in the general account of the insurance company selling the deferred annuity. The insurance company provides a minimum interest rate guarantee that will be applied to the account value and principle is guaranteed not to decrease. The account value of a variable deferred annuity is invested in sub-accounts of a separate account of the insurance company selling the deferred annuity. A “plain” variable annuity (VA) effectively transfers investment risk from the insurance company to the VA owner. This is because the owner chooses from among the offered investments in the variable account of the VA and experiences directly the investment ups and downs—including the possibility of capital losses.
In order to make variable annuity products more attractive to potential buyers, insurers have created a class of benefits referred to as guaranteed living benefits (GLBs) through which the insurer retains some of the investment risk that would otherwise have been transferred to the annuity owner. In deferred variable annuities these GLBs take a number of forms and all of these benefits are usually only available for election at the time the VA is issued.
One form is known as a Guaranteed Minimum Income Benefit (GMIB). This provides a minimum income or payout benefit at time of annuitization (if the VA is annuitized). If the actual accumulated account value would provide a higher benefit, then that higher income benefit is provided. The minimum may be expressed in many different ways and there may be restrictions imposed. For example, the GMIB is only available if the VA is annuitized and the contract may be required to be in force for a number of years before such annuitization. There is typically an additional fee for this benefit which has the effect of reducing the net investment return available.
Another form is known as a Guaranteed Minimum Accumulation Benefit (GMAB). The GMAB is similar to the GMIB except that the minimum is applied to the Accumulation Value. Any VA benefit that is set in relation to the Accumulation Value can be affected by this minimum. Therefore, annuitization may not be required to activate the benefit. The minimum may be expressed in a number of different ways and there may be restrictions on the application of the minimum. For example, the minimum benefit is typically only available on specified benefit dates (perhaps 10 years after issue) or may be available only in specified contingencies like nursing home confinement. There is typically an additional fee for this benefit which has the effect of reducing the net investment return available.
A third form is known as a Guaranteed Minimum Withdrawal Benefit (GMWB). This benefit allows the annuity owner to withdraw a set percentage or amount of the Accumulation Value over a set period of time. The benefit is, typically, designed to guarantee that at least the principal deposit into the VA contract will be available for withdrawal over time. Usually the guarantee allows the principal deposit accumulated at some guaranteed minimum rate of interest to be withdrawn over the specified period—something like 15-20 years. The minimum may be expressed in a number of different ways and there may be restrictions on the application of the minimum.
There is also Guaranteed Payout Annuity Floor (GPAF). An immediate, or payout, VA may also provide the GPAF which provides an annuitant receiving payout benefits a guaranteed minimum benefit. This guarantee might also be provided on a deferred VA with respect to benefits received through its annuitization feature. There is typically an additional fee for this benefit which has the effect of reducing the net investment return available.
Though not a GLB, through provision of a Guaranteed Minimum Death Benefit (GMDB) the insurer also retains some investment risk that would otherwise have been transferred to the VA annuity owner. The GMDB guarantees a death benefit equal to, at least, the premiums paid into the VA contract. Other forms of the GMDB relate the death benefit amount to the highest level of the Accumulation Value at points in the past. Typically the GMDB is provided as an embedded benefit for which a small charge has been reflected in the pricing. Therefore, the VA fees or charges are slightly higher which has the effect of reducing the net investment return available.
The account value of an indexed deferred annuity is invested in the general account of the insurance company issuing the policy. Indexed deferred annuities guarantee principal and interest rate guarantees applied to the account value are guaranteed by a rate calculated in reference to an index, such as for example the S&P 500 which is, generally, greater than zero. However, deferred annuities may be difficult to understand, are expensive to purchase because of fees and charges applied, reduce the liquidity of amounts invested by subjecting them to surrender charges, and do not provide protection for securities.
In view of the above, it would be desirable to protect an asset or a security from declining in value. It is also desirable to protect an individual's portfolio or a portion of the portfolio that may be comprised of combinations of various securities. It would also be advantageous to offer a product or contract, such as a deferred annuity whose account value in some way consisted of or was related to or indexed to a security or portfolio of securities, that would be able to protect against a change in the value of a security or portfolio of securities. There is also a need for insurance for an account value of a deferred annuity consisting of or related to or indexed to a security or a portfolio of securities. Together, this insurance or protection is a securities insurance guarantee.
The present disclosure is designed to obviate and overcome many of the disadvantages and shortcomings associated with attempting to protect the value of a security or a portfolio of securities. In particular, the present disclosure is a system and method for providing a deferred annuity which provides guarantees with respect to an account value related to or indexed to a security or a portfolio of securities. Moreover, the system and method of the present disclosure can be employed to insure or guarantee against a decrease or an increase in the price of a security or a portfolio of securities.